Pension Plan Lump Sum Payments: Why You Should Avoid Them

Earlier this week, during a CBS MoneyWatch video interview, John Carl, president of the Retirement Learning Center, offered this advice regarding retirement funds: "Consider a lump sum payment from your pension plan instead of an annuity stream of income." While the interview had plenty of other, good advice for retirement investors, I need to respectfully disagree with this particular advice regarding lump sums from pension plans.

Carl cited past situations where people lost their full pensions when the corporations they had worked for, including Bethlehem Steel, Delta Airlines, and Circuit City, went bankrupt. While these are indeed unfortunate situations, they represent the exception, rather than the rule.

The bottom line is, if you receive an annuity from a pension plan, the chances are excellent that you'll continue to get a monthly paycheck, no matter what happens in the economy and no matter how long you'll live. And that's a great thing for your retirement security.

I can't tell you how many times I've heard about people who retired, took a lump sum payment from their pension plan, invested it in the stock market, and are now in their seventies and broke. In fact, this happened to a relative of mine -- a financial executive for a well-known company! He's now back at work, driving a delivery truck. If this financial expert had trouble investing his lump sum and making it last for life, what about people who don't have any financial training?

Yes, you should be concerned if your company goes bankrupt, but in that case, your pension is guaranteed by a federal agency -- the Pension Benefit Guaranty Corporation (PBGC). It's like the FDIC for pensions. There are limits to the protection -- the maximum that's guaranteed is $4,500 per month if you start your pension at age 65. But most people's pensions are far below this limit.

The problem with a lump sum payment is that you've got to make it generate a lifetime retirement income, no matter how long you live, and this is a difficult challenge. Also, a lump sum from a pension plan is based on average life expectancies. So if you're healthy and live longer than the average, there's a good chance you might outlive your lump sum payment. It gets worse if you're a woman; for the purposes of calculating these lump sums, average life expectancies are mixed together for men and women, and women typically live longer than men. If you ever get the chance to receive a monthly retirement income for the rest of your life, take it!

Corporations that sponsor pension plans are required by federal law to fund them adequately in a trust fund that is protected from creditors. Yes, the trust funds took a hit in the recent stock market decline, but corporations are now pouring a lot of money into these plans to make up the deficits. This fact, combined with the PBGC guarantees, makes pensions a pretty safe bet for most people.

Most people will receive more retirement income over their lifetime with an annuity, compared to a lump sum payment. This is the result of an actuarial analysis that I've prepared, which you can read in a paper I wrote entitled Should You Take a Lump Sum from Your Pension Plan?It's available free of charge at my website www.restoflife.com; I give it to participants in my retirement planning workshops. This paper also addresses many misconceptions and myths about lump sum payments, and it includes a checklist for when a lump sum makes sense -- and when it doesn't.

If you're facing a decision about whether to take a lump sum payment from your company's pension plan, it might be a good idea to consult an unbiased professional advisor. Avoid advisors who have a vested interest in your decision (which usually means they want to invest your lump sum for you). You also want them to have the necessary skills and experience to help with your decision.

Whether to take a lump sum payment or a monthly payment is one of the most important retirement planning decisions you'll make. Don't make this decision without carefully considering all the factors. Don't bet your life!
P.S. After this post was published, John Carl responded by summarizing the reasons for taking lump sum payments. You can read them in the post below.

View all articles by Steve Vernon on CBS MoneyWatch»
Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.